Thursday, 24 January 2013

When Keynesian Policies won’t work

Japan is set to try yet another fiscal stimulus
but this is more about politics than following the ideas of Keynes.

Keynesian policies has made
a dramatic return after been shunned as a viable policy option. Firms and
households have reined in their spending due to uncertainty over the future
while banks cut back on lending after the global financial crisis. The resulting slump in demand has opened up a
role for governments to fill the gap in spending which is the core premise of
Keynesian economics. But this government action
is only ever meant to be a stopgap to boost demand until normal economic
conditions resume.

So a stimulus package
after an economy has been stagnating for two decades is beyond what Keynes
would proscribe. But this is what the
government in Japan is set to embark on.
As well as a likely waste of money, the extra government spending is
also a worry considering the high level of public debt in Japan and previous
stimulus policies which have resulted in a glut of public works being carried
out leaving Japan with lots of roads and bridges which are hardly used. But worst of all, it is used as an excuse to
put off reforms needed to rejuvenate the economy and may doom Japan to another
decade of missed opportunities for economic revival.

The newly elected
government, head by the new Prime Minister Shinzo Abe, released plans this
month for a stimulus package worth 10.3 trillion yen (US$116 billion). Abe has also bullied the Bank of Japan into
lifting the target for inflation from 1% to 2% as part of a push toward more
aggressive policy to get the country out of deflation. But this is the same prescription that has
been administered before in Japan and the outcome will probably be the same too
– a short term boost bought with more debt.
To add to this, the Liberal Democratic Party (LDP) which Abe heads does
not have the best track record. Its
previous numerous stimulus packages have been more notable for extending the
LDP’s hold on power through building needless infrastructure in remote regions
to secure votes. The LDP maintained its
stranglehold on Japan for over 50 years of almost uninterrupted rule and was
only voted out of government in 2009 despite presiding over two decades of
economic stagnation following the bursting of one of the largest ever asset
bubbles at the end of the 1980s.

The LDP is expert at
looking as if it is doing something while not actually dealing with the core
problems, but even more perversely, it is making things worse by adding to
Japan’s mountain of debt. Government debt
in Japan which reached 237% of GDP in 2012 – the highest among developed
countries. Government debt is still
increasing at a rapid rate with a budget deficit of 10% in 2012. Japan’s only saving grace is that it is
mostly Japanese banks buying government bonds and Japanese savers have
tolerated the meagre returns which banks have been able to offer up as a
result. So Japan has been saved from a
debt crisis like that which has plagued Europe but it has also allowed
politicians to put off making the necessary changes and ballooning debt must
eventually have consequences such as higher interest rates which may trigger
bigger problems.

The persistent
sluggishness of the Japanese economy suggests that it is not a shortfall of
demand that can be fixed by a fiscal shot in the arm but changes need to be
made to help the economy work better.
For a country that relies heavily on exporting, it is relatively closed
off to imports which reduces competition and results in higher costs for
households and businesses. Japan has
many global firms but it is also a tough place to start a business. Wages and prices also need to be able to move
so the economy can adapt to new circumstances.
Change in Japan will not come from the policies enforced top-down but
need to bubble up from below through the activities of individuals and
start-ups and the government just need to put in place the reforms to make this
happen. Yet, there are few signs of this
happening even after an economic slump lasting over two decades. It is a scary look into the future for leaders
in Europe.